Chapter 3 CVP

Chapter 3
Cost-Volume-Profit Analysis
©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Cost-Volume-Profit Assumptions
and Terminology
1. Changes in the level of revenues and costs arise

only because of changes in the number of product
(or service) units produced and sold.
2. Total costs can be divided into a fixed component
and a component that is variable with respect to
the level of output.

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and Terminology
3. When graphed, the behavior of total revenues

and total costs is linear (straight-line) in relation
to output units within the relevant range
(and time period).
4. The unit selling price, unit variable costs, and
fixed costs are known and constant.

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and Terminology
5. The analysis either covers a single product or

assumes that the sales mix when multiple
products are sold will remain constant as the
level of total units sold changes.
6. All revenues and costs can be added and
compared without taking into account the time
value of money.
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and Terminology
Operating income
= Total revenues from operations
– Cost of goods sold and operating costs
(excluding income taxes)
Net income = Operating income – Income taxes

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Essentials of Cost-Volume-Profit
(CVP) Analysis Example
Assume that the Socks Shop can purchase Socks

for $32 from a local factory; other variable costs
amount to $10 per unit.
The local factory allows the Socks Shop to
return all unsold Socks and receive a full $32
refund per pair of socks within one year.
The average selling price per pair of Socks is $70
and total fixed costs amount to $84,000.
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How much revenue will the business receive if

2,500 units are sold?
2,500 × $70 = $175,000
How much variable costs will the business incur?
2,500 × $42 = $105,000
$175,000 – 105,000 – 84,000 = ($14,000)
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What is the contribution margin per unit?

$70 – $42 = $28 contribution margin per unit
What is the total contribution margin when
2,500 pairs of Socks are sold?
2,500 × $28 = $70,000

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Contribution margin percentage (contribution

margin ratio) is the contribution margin per
unit divided by the selling price.
What is the contribution margin percentage?
$28 ÷ $70 = 40%

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If the business sells 3,000 pairs of Socks,

revenues will be $210,000 and contribution
margin would equal 40% × $210,000 = $84,000.

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Breakeven Point
Variable Fixed
Sales – expenses = expenses
Total revenues = Total costs

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Abbreviations
SP = Selling price
VCU = Variable cost per unit
CMU = Contribution margin per unit
CM% = Contribution margin percentage
FC = Fixed costs

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Abbreviations
Q = Quantity of output units sold

(and manufactured)
OI = Operating income
TOI = Target operating income
TNI = Target net income

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Equation Method
(Selling price × Quantity sold) – (Variable unit cost

× Quantity sold) – Fixed costs = Operating income
BEQ= FC/UCM
$70Q – $42Q – $84,000 = 0
$28Q = $84,000
Q = $84,000 ÷ $28 = 3,000 units

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Target Operating Income
Q (TOI) = Fixed costs + Target operating income)

divided either by Contribution margin
percentage or Contribution margin per unit

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Target Operating Income
Assume that management wants to have an

operating income of $14,000.
How many pairs of socks must be sold?
($84,000 + $14,000) ÷ $28 = 3,500
What dollar sales are needed to achieve this income?
($84,000 + $14,000) ÷ 40% = $245,000
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Target Net Income
and Income Taxes Example
Management would like to earn

an after tax income of $35,711.
The tax rate is 30%.
What is the target operating income?
Target operating income
= Target net income ÷ (1 – tax rate)
TOI = $35,711 ÷ (1 – 0.30) = $51,016
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Target Net Income
How many units must be sold?

Revenues – Variable costs – Fixed costs
= Target net income ÷ (1 – tax rate)
$70Q – $42Q – $84,000 = $35,711 ÷ 0.70
$28Q = $51,016 + $84,000
Q = $135,016 ÷ $28 = 4,822 pairs of socks
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Target Net Income
Proof:
Revenues: 4,822 × $70 $337,540
Variable costs: 4,822 × $42 202,524
Contribution margin $135,016
Fixed costs 84,000
Operating income 51,016
Income taxes: $51,016 × 30% 15,305
Net income $ 35,711
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Using CVP Analysis Example
Suppose the management anticipates

selling 3,200 pairs of Socks.
Management is considering an advertising
campaign that would cost $10,000.
It is anticipated that the advertising will
increase sales to 4,000 units.
Should the business advertise?
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3,200 pairs of Socks sold with no advertising:

Fixed costs 84,000
Operating income $ 5,600
4,000 pairs of socks sold with advertising:
Fixed costs 94,000
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Instead of advertising, management is

considering reducing the selling price
to $61 per pair of Socks.
It is anticipated that this will increase
sales to 4,500 units.
Should management decrease the selling
price per pair of Socks to $61?
3,200 pairs of Socks sold with no change

in the selling price:
Operating income = $5,600
4,500 pairs of socks sold at a reduced selling price:
Contribution margin: (4,500 × $19) $85,500
Fixed costs 84,000
Alternative Fixed/Variable Cost
Structures Example
Suppose that the factory the Socks Shop is using to

obtain the merchandise offers the following:
Decrease the price they charge from $32 to $25 and
charge an annual administrative fee of $30,000.
What is the new contribution margin?

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Structures Example
$70 – ($25 + $10) = $35

Contribution margin increases from $28 to $35.
What is the contribution margin percentage?
$35 ÷ $70 = 50%
What are the new fixed costs?
$84,000 + $30,000 = $114,000
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Structures Example
Management questions what sales volume

would yield an identical operating income
regardless of the arrangement.
28x – 84,000 = 35x – 114,000
114,000 – 84,000 = 35x – 28x
7x = 30,000
x = 4,286 pairs of socks
Operating Leverage
Operating leverage describes the effects that

fixed costs have on changes in operating
income as changes occur in units sold.
Organizations with a high proportion of fixed
costs have high operating leverage.

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Operating Leverage Example
The degree of operating leverage at a given level

of sales helps managers calculate the effect of
fluctuations in sales on operating income.
Degree of operating leverage
= Contribution margin ÷ Operating income
DOL (Old Arrangement)

$98,000 ÷ $14,000 = 7.0
DOL (New Arrangement)
©2003 Prentice Hall Business$122,500
3/7/2015 ÷ $8,500
Publishing, Cost Accounting = 14.4
11/e, Horngren/Datar/Foster
Effects of Sales Mix on Income
Socks Shop Example

Management expects to sell 2 shirts at $20 each
for every pair of socks it sells.
This will not require any additional fixed costs.
Variable cost per shirt is Br 9

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Contribution margin per shirt: $20 – $9 = $11

What is the contribution margin of the mix?
$28 + (2 × $11) = $28 + $22 = $50

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$84,000 fixed costs ÷ $50 = 1,680 packages

1,680 × 2 = 3,360 shirts
1,680 × 1 = 1,680 pairs of socks
Total units = 5,040

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What is the breakeven in dollars?

3,360 shirts × $20 = $ 67,200
1,680 pairs of socks × $70 = 117,600
$184,800

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What is the weighted-average budgeted

contribution margin?
Socks: 1 × $28 + Shirts: 2 × $11
= $50 ÷ 3 = $16.667

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The breakeven point for the two products is:

$84,000 ÷ $16.667 = 5,040 units
5,040 × 1/3 = 1,680 pairs of socks
5,040 × 2/3 = 3,360 shirts

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Sales mix can be stated in sales dollars:

Socks Shirts
Sales price $70 $40
Variable costs 42 18
Contribution margin $28 $22
Contribution margin ratio 40% 55%

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Assume the sales mix in dollars

is 63.6% socks and 36.4% shirts.
Weighted contribution would be:
40% × 63.6% = 25.44% socks
55% × 36.4% = 20.02% shirts
45.46%

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Breakeven sales dollars is $84,000

÷ 45.46% = $184,778 (rounding).
$184,778 × 63.6% = $117,519 sock sales
$184,778 × 36.4% = $ 67,259 shirt sales

3/7/2015

Chapter 3 CVP

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Chapter 3 CVP

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Chapter 3

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

1. Changes in the level of revenues and costs arise

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

3. When graphed, the behavior of total revenues

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

5. The analysis either covers a single product or

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Assume that the Socks Shop can purchase Socks

How much revenue will the business receive if

What is the contribution margin per unit?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Contribution margin percentage (contribution

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

If the business sells 3,000 pairs of Socks,

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Total revenues = Total costs

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Q = Quantity of output units sold

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

(Selling price × Quantity sold) – (Variable unit cost

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Q (TOI) = Fixed costs + Target operating income)

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Assume that management wants to have an

Management would like to earn

How many units must be sold?

Suppose the management anticipates

3,200 pairs of Socks sold with no advertising:

Instead of advertising, management is

3,200 pairs of Socks sold with no change

Suppose that the factory the Socks Shop is using to

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

$70 – ($25 + $10) = $35

Management questions what sales volume

Operating leverage describes the effects that

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

The degree of operating leverage at a given level

DOL (Old Arrangement)

Socks Shop Example

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Contribution margin per shirt: $20 – $9 = $11

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

$84,000 fixed costs ÷ $50 = 1,680 packages

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

What is the breakeven in dollars?

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

What is the weighted-average budgeted

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

The breakeven point for the two products is:

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Sales mix can be stated in sales dollars:

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Assume the sales mix in dollars

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

Breakeven sales dollars is $84,000

©2003 Prentice Hall Business Publishing, Cost Accounting 11/e, Horngren/Datar/Foster

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